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Valuation Provisions of a Buy/Sell Agreement
When was the last time you looked at your buy/sell agreement? Chances are it's been a while. Some of you may not even know where your buy/sell agreement is or worse yet - don't have one at all. The purpose of such an agreement is to establish a process by which shareholders of a privately held business can both create liquidity in their shares and limit exposure to unintended shareholders upon a specific triggering event such as the death of a shareholder. One of the most important provisions of the agreement deals with how the shares are to be valued. All too often we see formulas inserted such as "6 Times Trailing EBITDA" or even worse a "stated value" which hasn't been updated since 1981. These formulas or stated values may have had validity at the time they were drafted and put in place, but businesses change and economic conditions change, thus the value of the business will change. Rigidity in value coupled with changing business and economic conditions can lead to serious under or over valuation at the time of a triggering event.
What the shareholders likely intend is that
is achieved upon a triggering event. We suggest considering a
to be followed when a life event occurs.
Such a process would define who is qualified to conduct the business valuation.
Are they accredited in business valuation with recognized professional societies?
What standards will they be asked to perform under?
Most business appraisers today follow what is known as Uniform Standards of Professional Appraisal Practice (USPAP).
What valuation approaches should the appraiser consider?
There are three main approaches to value: the income approach, the asset approach and the market approach. Consideration of each approach is often the best route to follow.
What adjustments should the appraiser consider?
Should officer compensation be adjusted to reasonable replacement cost or should real estate be adjusted from net book value to fair market value? Giving the appraiser guidelines to follow is important.
Should the appraiser consider application of discounts or premiums?
The application of discounts for lack of control, lack of marketability or premiums for voting control can have tremendous impact on the value of the shares in question.
Spending the time today to define a proper valuation process will help ensure that a fair and reasonable value is concluded upon a triggering event. If you haven't looked at your buy/sell agreement in a while, we suggest you do so soon.
To discuss this topic further and design a valuation provision that is right for you, please contact your local UHY LLP professional.